Hedging in terms of Future and options in Stock Market

Introduction- Futures and Options

What is Stock Market Hedging- Using Future/Options

Hedging Pre-requisites

Strategies-

Benefits of Hedging

Content

Derivative Market Structure

3

Stock Futures

Stock options

Call Options

Put Option

4

Direction/ view/Trend of Market. (Up,Down,Sideways)

Up Trend

Down Trend

Sideways Trend

Four kind of Market Situation

Bullish Market

Bearish Market

Volatile Market

Sideways/Non volatile Market

Take stock delivery

Buy stock future

Buy Call option

Sell put option

Bull call spread

Ratio call spread

Buy Put and buy future

Basic Strategies - Bullish Market Trading Strategy-HEDGING

Sell stock future

Buy Put option

Sell Call option

Bear Put spread

Ratio Put spread

Sell stock and buy Call

Basic Strategies - Bearish Market Trading Strategy

Volatile Market

Straddle

Strangle

Sideways Market

Sell straddle

Sell Strangle

Basic Strategies- Volatile & Sideways

Introduction-Hedging

Portfolio protection :-

Sell stock future

Buy puts

Buy Index puts

Sell Nifty Futures

Introduction-Hedging

Hedging reduces risk.

Hedging involves establishing other position whose price behavior will

likely offset the price behavior of the original portfolio.

The objective of portfolio protection is the temporary removal of some or

all the market risk associated with a portfolio.

Using Options

Equity options with a stock future

Index options ( Nifty)

Importance of delta Protective puts Writing covered calls

Importance of Delta/Beta

Delta is a measure of the sensitivity of the price of an option to changes in

the price of the underlying asset:

Importance of Delta

Delta enables the to figure out the number of option contracts

necessary to mimic the returns of the underlying security. Beta measures how much a stock would rise or fall if the market rises /

falls. The market is indicated by the index, say Nifty 50.

Example- Hedging using index

Investor Buy 1000 shares of Reliance @ 800(approximate portfolio value of Rs. 8,00,000. However, the investor fears that the market will fall and thus needs to hedge.

January Nifty futures is trading 6150 The beta of Reliance is 1.25 To hedge, the investor needs to sell [Rs. 8,00,000 *1.25] = Rs. 10,00,000

worth of Nifty futures (10,00,000/6150 = 162 Nifty Futures) 3 lots

Warning: Hedging involves costs and the outcome may not always be favorable if prices move in the reverse direction.

Example- Hedging by Selling Stock Futures and Buying in Spot market

Investor Buy 1000 shares of Reliance @ 800(approximate portfolio value of Rs. 8,00,000. However, the investor fears that the market will fall and thus needs to hedge.

The Reliance futures (near month) trades at Rs. 806. To hedge, the investor will have to sell 1000 Reliance futures.

Warning: Hedging involves costs and the outcome may not always be favorable if prices move in the reverse direction.

Example- Hedging by buying Put option

Investor Buy 1000 shares of Reliance @ 800(approximate portfolio value of Rs. 8,00,000. However, the investor fears that the market will fall and thus needs to hedge.

Stock delta is always 1 ATM put delta is always 0.50 To hedge, the investor will have to buy 2000 Reliance 800 strike put

option.

Warning: Hedging involves costs and the outcome may not always be favorable if prices move in the reverse direction.

Protective Puts

A protective put is a long stock position combined with a long put position

Protective puts are useful if someone:

Owns stock and does not want to sell it

Expects a decline in the value of the stock

Writing Covered Calls

Appropriate when an investor owns the stock, does not want to sell it, and

expects a decline in the stock price

An imperfect form of portfolio protection

The premium received means no cash loss occurs until the stock price falls

below the current price minus the premium received

Index Options

Investors buying index put options:

Want to protect themselves against an overall decline in the market

Want to protect a long position in the stock

If an investor has a long position in stock:

The number of puts needed to hedge is determined via delta.

Differences

Protective puts provide protection against large price declines, whereas

covered calls provide only limited downside protection. Covered calls

bring in the option premium, while the protective put requires a cash

outlay.

Identify the risks

Distinguish between hedging and speculating

Evaluate the costs of hedging in light of the costs of not hedging

What is our objective?

Should we hedge at all?

If so, how much should we hedge?

What hedging instruments should we use (Futures, Options)

What tenor should we hedge (1 months, 3 months, etc.)?

Hedging Pre-requisites

EXECUTION MONITORING REPORTINGOBJECTIVE STRATEGY

1. Which instrument to hedge?

1. Further adjustment

1. Should we hedge?

2. When to hedge?

1. How a hedge would perform under different market conditions?

1. What is the actual MTM for accounting purposes?

Mitigate - price risk

Safeguard - Profit Margins

Helps in making forecasting decisions, which are well supported by

rational statistical analysis

Provide confidence that the company has a well disciplined process to

manage market uncertainties

Benefits of Hedging

• “McMillan on Options” by Lawrence G. McMillan• “Bible of Option Strategy” by Guy Cohen• “Technical Analysis” by Charles D. Kirkpatrick II• “Technical Analysis Of The Financial Markets” by John

Murphy

• www.theoptionsguide.com• www.stockcharts.com/education/

Recommended Books on Options/Technical Analysis

Thank You….

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